Excel Inc Limited Steel Division is considering the proposal to buy new machine to produce a new product for the potential 3 year contract. New machine will cost= $1.12 million. Machine has the approximate life of 3 years for accounting & taxation purposes. Contract won’t continue beyond 3 years and equipment approximate salvage value at the ending of 3 years= $105,000. Tax rate is 28 percent and is payable in year following the year in which profit is earned. Investment allowance of 30% on outlay is available. Cost of capital is 13.25%pa. In addition net working capital= $72,000 is needed immediately for present assets to support project. Suppose that this amount is recovered at the ending of three year life of project. New product will be charged $53,000 of allocated head office administration costs each year although head office won’t actually incur any extra costs to manage the project. This is in accordance with firm’s policy of allocating all corporate overhead costs to divisions. Extra marketing and administration cash outflows of $43,500 per year will be incurred by Steel Division for project. The amount of $59,000 has been spent on the pilot study and market research for new product. Projections given here are based on this work. Projected sales for new product= 32,000 units at $135 per unit per year. Cash operating expenses are approximate to be 73% of sales (excludes marketing and administration, and head office items). Except for initial outlays, suppose cash flows occur at the ending of each year (unless otherwise stated). Suppose prime cost depreciation for tax purposes. Any losses should be carried forward and offset by income in given year.
Questions
(i) Create the table illustrating your computationa of net cash flow after tax.
(ii) Compute NPV. Is the project acceptable? Describe why or why not?
(iii) Write a brief report describing your computations of applicable net cash flows after tax, justifying your choice of cash flows. Make sure to mention clearly any suppositions made (implicit and explicit).